As forecasts for the severity of the economic downturn are worsening, so are the prospects of banks coming through the crisis intact. Expectations for a sharp “V-shaped” recovery are fading amid the realization that social distancing – and economic activity – will lead to a slump that could last several quarters. There is no visibility as to when or how quickly economic activity will resume.
Deutsche Bank AG analysts forecast an annualized GDP contraction of 24% in the euro area and 13% in the U.S. in the second quarter. At this rate, the decline would be more than one and a half times greater than the financial crisis.
Even with considerably more equity than a decade ago, banks remain inherently levered institutions. Borrowings of banks from JPMorgan Chase & Co. to Deutsche Bank AG to HSBC Holdings Plc exceed their capital by more than 15 times. Stress tests show the biggest lenders have sufficient capital, but it’s debatable whether these assessments capture the magnitude of the downturn ahead. Nor do they model the implications of the synchronized shutdown that is paralyzing large, interconnected economies.
In the U.S. stress tests last year, banks’ resilience was measured against a real GDP decline of 8% from the pre-recession peak and a surge in the CBOE Volatility Index, or VIX, to 70. The index, often referred to as the fear gauge, soared past 80 this week for the first time since 2008.
The Institute of International Finance estimates that at $75 trillion non-financial corporate debt is worth around 93% of global gross domestic product, up from about 75% of GDP before the financial crisis, with some of the highest burdens in sectors with weak earnings, such as small and medium-sized companies.
Analysts at Goldman Sachs Group Inc. estimate that if credit lines across travel, commodities and energy get fully drawn, the liquid assets held by the top U.S. banks to cover draw-downs would come close to regulatory minimums. Executives from UBS Group AG, Credit Suisse Group AG and Deutsche Bank told a virtual conference this week they’re seeing clients drawing on credit lines, regardless of whether the cash is needed now.
To be sure, central banks and governments have raced to ramp up their stimulus and are taking steps to ensure credit keeps flowing to the economy. From cutting interest rates, to resurrecting a commercial paper backstop, in a matter of days the U.S. Federal Reserve has gone through the financial crisis catalog of fixes.
Even against that backdrop, banking supervisors rightly see the need to be accommodating with lenders. Post-crisis measures, some of which were designed to be eased in times of economic slowdown, are being rolled back. Banks will be allowed to let capital ratios fall - an inevitable function of assets going bad - and in Europe stress tests have been postponed.
Regulators in Europe are also reportedly considering giving banks more time to set aside provisions for loans that will undoubtedly sour.
At first, such measures looked like potentially detrimental regulatory forbearance. Perhaps not now. Deutsche Bank warned on Friday it may be “materially adversely affected” by a protracted downturn. As the economic impact of radical steps to curb the coronavirus worsens, the challenge will be to keep the banking sector part of the solution rather than part of the problem.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.
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